DIY investing: what to look out for

September 2 2012 at 12:00pm
By Bruce Cameron

You may well be better off spending time making money from doing your own job and leaving the management of your savings and investments to others who have the time and expertise to do the job properly. But this does not mean you should not learn about the basics of investment, which is in your own best interests, Martin Poole says.

He says any do-it-yourself task, whether gardening or undertaking repairs to your home, requires time, expertise and having access to the right tools.

Often, it is better and cheaper to leave it to the experts; if you botch the job, you may end up having to call them in at additional expense.

Poole says people opt for DIY investing for a number of reasons. These include:

* Personal satisfaction or interest. For example, many people enjoy tending a garden – the time and cost do not matter. But the sense of satisfaction could be outweighed by the time it takes to do the job properly in all types of weather (investment market conditions).

* Greater control over and understanding of what is owned in your name. Poole says there is no reason you should not learn about investments even where you retain the services of a professional adviser. This will help you to understand the advice you receive and what is happening to your investments, allowing you to make more informed decisions. This means partnering with your financial planner.

Taking control of your investments requires learning a new language that includes jargon such as special purpose vehicles, non-recurring income, write-offs and debt covenants. And it requires mastering skills such as reading balance sheets and income statements, and selecting and understanding products.

He says there are various levels of DIY investing – from selecting every share or other security, to using index-tracking investments – that require greater or lesser degrees of knowledge and time.

* Greater control of costs. You may save money by not paying fees for advice, but the absence of advice may result in your making incorrect decisions that will cost you more in the end. You need to know what tools you need for the job and how to maintain them, and have a proper understanding of how these tools work.

An expert should have all the tools and should be able to implement an investment plan efficiently with a greater probability of success, while saving you time.

However, Poole says you will then have higher fixed costs and may face the risk of “unscrupulous or incompetent experts”. You do have the recourse to redress for bad advice, by complaining to the financial advice ombud, who can order that you are compensated for losses as a consequence of inappropriate advice.

* Popular backlash at financial services. Poole says the poor reputation of the financial services industry may lead you to believe that you must have greater control of your money, but you need to understand the level of knowledge and how much work it entails to have the required level of control to counter inappropriate products.

* Greed or desperation. Poole says behavioural problems may drive DIY investing, particularly when it is contrary to the advice of an adviser who may opt for a more cautious, less risky approach to investment.

Often investors are driven to take greater risks because they are too greedy or are desperate to improve their standard of living, and they take imprudent chances that are more akin to gambling.

DON’T BET ON BIG PROFITS IN THE SHORT TERM

Many do-it-yourself investors do not understand the difference between investing and gambling, Martin Poole says. And the problem is compounded by the fact that there is a large grey area between pure investing and gambling.

Investing, Poole says, entails making choices for the medium to longer term while diversifying your investments across asset classes and protecting the value of your capital by limiting risks to those that are weighted in your favour.

Gambling involves making short-term investment choices, chasing anticipated large pay-offs, with profit as your only motive and the odds stacked against you (in other words, you are likely to lose your capital).

He says gambling is placing a bet before the recent third cricket test between England and South Africa that Kevin Pietersen would score 50 runs – and then losing all your money because he did not play.

Poole says some people argue that all investing is gambling, and that it relies on the “greater fool” theory.

The theory works like this: if you buy a share for R10 because that is what you think it is worth, the greater fool buys the share from you at R11 because he thinks it is worth more. But you bought the share from someone who paid R9 ...

He says the trend towards gambling can be seen by how long investors hold shares traded on stock exchanges.

In 1993, shares on the JSE were held for an average of 20 years. By 2010, the average had dropped to two years and six months.

For example, he says, if you had invested on the JSE at the beginning of 2008, when shares were expensive, and had disinvested at the end of the year, you would have lost 23 percent on average over the year. But if you had been invested in 1992 and had held on to your investment until 2011, you would have received an average return of 15.1 percent a year, despite the 2008 loss.

Poole says all too often DIY investors invest when a market peaks and, instead of waiting out a market reversal, disinvest at the bottom of the market.

You need to take account of factors such as peaks and troughs when investing for the long term, he says. You should consider, for example, the price of a share relative to the profits the company may make. This is known as the price-to-earnings multiple or p:e ratio.

The p:e ratio for all companies listed on the JSE averages between 11 and 13. In other words, if a listed company has a p:e of 12 it will take 12 years to pay back the cost of a share from constant profits. When the JSE p:e starts to move above average levels, you should become more cautious about investing rather than seeing it as an opportunity.

FOR SUCCESS, BE A SCEPTIC

If you want to hold onto your savings, remain a sceptic, Martin Poole of acsis says.

He says if you get emotionally involved this can lead to losses and gains, but mostly losses.

Poole warns that product providers, particularly of high-risk investments, will appeal to your ego, entice you with words such as “free”, and appeal to your greed by offering high returns and making it easy for you to invest. And they will throw the face of a pretty, happy woman into the mix just to make you feel part of the in-crowd.

“The first question you should ask yourself is: why would I want to invest in the product anyway?

“Then assuming you understand the ins and outs of the product, the next question is: ‘If it is so easy and so successful, why are the promoters selling this information or product?’”

Poole says an example is the plethora of so-called foreign currency traders who want to sell their secrets to you. There are some successful currency traders, but they are not giving away their secrets, he says.

Investment markets are not predictable, and some markets, such as currencies, are less predictable than others, he says.

He says that when investing you need to ask yourself questions such as:

* What return do I need to earn and what cost am I prepared to pay to earn a particular return?

* What could happen to my money? For example, consider the impact of different factors, including:

– Risk. What are the best and worst likely outcomes of an investment? In other words, what can go wrong and who on the other side of the investment is also trying to profit?

– Liquidity. Will I be able to access the money if I need it?

– Tax. Which taxes will apply to things such as interest, dividends and capital gains?

– Legal structures. What type of investment vehicle should I use? These range from regulated products such as unit trust funds through to unregulated investments such as property syndications.

– Time. How long do I want to invest the money and how will inflation reduce my returns?

– Unique factors. Are your choices limited because, for example, you do not want to invest in anything that produces weapons, damages the environment, produces alcohol or earns interest?

RISK ONLY YOUR SURPLUS ASSETS

If you are intent on DIY investing, start with what you can afford to lose, Martin Poole says.

He says you need to divide your assets into four groups:

* Your business assets – the assets that generate your income.

* Your lifestyle assets – for example, your home.

* Your lifetime assets – your retirement fund savings.

* Your surplus assets – these are assets you may be able to afford to lose.

However, he says that investing is not about “epic trades”. It is about things such as generating income (your business assets). The more income you earn and the less you spend, the more capital you are likely to have and the more your capital will grow from investment returns.

Much of the expertise you will require is not obvious and you must be “prepared to pay school fees”, particularly as direct costs and losses may be greater than you expect.

However, any losses will provide valuable lessons for the long run.

He says most of all you must be true to yourself. This includes not misleading yourself about a single “epic trade” that you can boast about around the braai while forgetting about the losses, creating the illusion of knowledge.

Instead of searching for evidence that you are about to make or have made a good investment, you should rather look for evidence that could show that the decision could be bad.